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by: Arturo Runolfsson


Marketplace > James Madison University > Economcs > ECON 365 > ECONOMIC DEVELOPMENT
Arturo Runolfsson
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Bruce Brunton

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Bruce Brunton
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This 8 page Study Guide was uploaded by Arturo Runolfsson on Saturday September 26, 2015. The Study Guide belongs to ECON 365 at James Madison University taught by Bruce Brunton in Fall. Since its upload, it has received 16 views. For similar materials see /class/214165/econ-365-james-madison-university in Economcs at James Madison University.

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Date Created: 09/26/15
Market Failure vs Government Failure Market failure the market is said to lead to a misallocation of present and future resources or to an allocation that may not be in the best longrun social interest Three forms market cannot function properlyno market exists market exists but implies an inefficient allocation of resources market produces undesirable results as measured by social objectives Argument Commodity and factor markets are badly organized and the existence of distorted prices often means that producers and consumers are responding to economic signals and incentives that are a poor reflection of the real cost to society Governments should have a role in integrating markets and modifying prices 1 Resource mobilization and allocation skilled workers must be employed where their contribution will be most widely felt The government can do this through planning AttitudinalzPsychological impact A central government can provide needed incentives to cut 2 across raceclassreligioustribal factions 3 Foreign aid Governments are better equipped to solicit foreign aid are more legit Government failure government policy in many LDCs has exacerbated rather than reconciled divergences between private and social valuations of benefits and costs For example public policy has raised the level of wages above labor s shadow prices social measures of the unit values of all project inputs and outputs Also investment depreciation tax allowances overvalued exchange rates low effective rates of protection quotas and credit rationing CAUSES 1 Deficiencies in plans and their implementation Plans are overambitious grandiose in design but vague on specific policies 2 lnsufficientZUnreliable data when data which a plan is based on are weak unreliable or non existent as it is in many poor countries 3 Unanticipated economic disturbances Because most LDCs are open economies it becomes exceedingly difficult for them to engage in longrange planning 4 Institutional weaknesses the separation of the planning agency from the daytoday decision making machinery of government failure of public administrators to participate in continuous dialogue Incompetent and unqualified civil servants cumbersome bureaucratic procedures 5 Lack of political will lack of commitment to challenge powerful elites and interst groups and persuade them that the interest of all citizens is what is important Limitations of markets in LDCs Producers are unsure about markets size presence of competition availability of inputs Many goods have high social value but must be produced at below market prices health care education This provides no profit incentive for market firms Governments must play a major role in accumulating capital especially in investment of infrastructure Market may be more efficient but can also produce very high income inequality The market may be efficient in the margins but may be ineffective in producing large changes in economic structure that are crucial to development Washington vs Santiago Consensus Washington Consensus No mention of shared growth focus on eliminating absolute poverty or reducing inequality Takes a free market approach even in fields such as the financial sector where market failure has been prevalent The state has a broader role in successful development experiences than the Washington Consensus would expect Santiago Consensus Emphasis on government s responsibility to focus on poverty alleviation Free market policies of 80s and 90s did not help the poor Draws some from Washington stress on marketbased development and limiting government s roles in direct production Government has a role in development of human capital People who are sick or uneducated are unable to take advantage of a well functioning market World Bank Reportllt s the GovernmentI Stupid World Bank Report State s unique strengths tax prohibit punish require participation State s unique challenges clarifying objectives ensuring that government employees pursue these objectives Volunteer sector sometimes fills in gaps from the government Good for public awareness but their interests is often only for certain groups religious ethnic Goals 1 Match state39s role to its capacity through institutional rules and norms that will enable the state to provide collective goods and services efficiently 2 Reinvigorate state39s capabilities through rules partnerships and competitive pressure outside and within the state Goal 1 Countries with low capability should focus first on basic functions pure public goods such as property rights macro stability control of disease safe water roads and protection of the poor Beyond this are intermediate functions management of externalities pollution regulation of monopolies provisions of social insurance pensions unemployment Final functions include activist functions such as dealing with the problem of missing markets by helping coordination Design must fit capability of state State doesn t have to be the ONLY provider of health education infrastructure lnsurance aims to help smooth out incomes through inevitable ups and downs unemployment benefits assistance aims to provide some minimum level of support to the poorest in society food stamps Goal 2 improvements are only possible if the incentives under which states and state institutions operate are changed Rules and norms are needed to create incentives for state agencies and officials to act in collective interest Rules and restraints mechanisms for enforcing rule of law independent judiciary competitive pressure recruitment of civil servants based on merit contracting for services and allowing private providers to compete directly with public agencies trade and global bond markets Voice and partnership institutional working arrangements with community groups It s the government stupid Basic institutions are necessary such as those that provide property rights or a reliable legal system 810 respondents to a survey of LDCs lacked confidence in the protection of their property rights 710 thought judicial arbitrariness was a big problem 40 claimed they had to pay bribes as a matter of course Two factors per capita income and government credibility explain 70 of the difference in investment between countries Two strategies to help feeble governments become successful bolster policies with strict rules that make them difficult to reverse such as a currency board design policies that can be implemented by private firms such as making sure bank executives have initiatives to act according to plan rather than smothering them with regulation Independent judiciaries to check arbitrary state action better bureaucracy Pay bureaucrats well measure their performance Policy formation Two views 1 Effective government not only necessary due to market failure but sufficient to achieve economic development 2 Participants in government are selfish just like selfinterested owners of companies but lack the market to constrain them General framework People may be assumed to oppose policy changes if they think they are likely to personally lose by them and sometimes those they believe are morally right even if they will lose through them selfinterest standard of rationality Sometimes reform supports the interest of the few at the cost of the many and the majority will revolt if they can Sometimes the majority opposes policies that the majority will gain from This can be due to lack of understanding of economics or uncertainty about who will gain and who will lose Progress tends to be more common than theory suggests U nderstanding policy formation includes examining the tradeoffs between short term losses and long term gains from policy nstitutions affect economic behavior because they define incentives Path dependency past conditions affect future conditions a trap Democracy vs Autocracy Democracy politicians seeking reelection have incentive to reflect the will and interests of the majority However a looming election gives precedence to shortterm accomplishments rather than long term development Corrupt politicians who know they will soon relinquish their role have incentive to steal as much as possible Autocrats can more easily implement policies but can also implement bad policies for private gain Studies find about 13 democracy is better 13 autocracy and 13 neutral Privatization For the full sample the study showed significant increases in profitability operating efficiency capital investment output and employment Profits as firms move from public to private ownership profits should increase Transfers control rights and cash flow rights to managers who are more interested in profit than pleasing the government fficiency Greater emphasis on profit should lead firms to act more efficiently This was true according to the study This is generally the most common objective of governments launching privatization programs More investment Greater efficiency will lead to higher capital investment spending Higher output Efficiency 9 higher output Study confirms real sales up 25 on average Employment Efficiency is expected to lead to less employment but employment increased for 58 of the sample by an average of 13 Significant for firms in noncompetitive industries partial privatizations and for firms headquartered in lowincome and lowermiddleincome countries everage decreased Effect was not shown the be as great in subsamples In addition privatized companies must have competition to achieve these goals There s no reason to be efficient when you39re a monopoly Non Government Organizations Todaro39s Argument For 1 Innovation Design and implementation of programs focused on poverty reduction and other development goals For example NGOs work directly with the poor and may design new and more effective programs that reach the poor Government has an advantage in scaling up existing programs but has been less successful than NGOs at innovating these programs 2 Flexibility NGOs can address development issues viewed as important for communities in which it works Greater flexibility in altering program structure than a government can Can change quickly but must also change to fit donations donor capture 3 Specialized technical knowledge NGOs may be greater repositories of technical expertise and specialized knowledge than governments They can draw on the experiences of many countries and use many different models because they are internationallyreaching 4 Targeted local public goods goods and services that are rival can be used up and excludable people can be prevented from using can be best designed to fit certain groups by NGOs who work with these groups Examples include local public health facilities nonformal education crating local markets community mapping and property registration 5 Commonproperty resource mana ement design and implementation Ensuring sustainability of forests lakes fishing areas pasturelands and other commons rivalnonexcludable Governments and the private sector have failed here Changes can include training assistance with organizational development efforts to change noncooperative cultural norms and communityproperty policing 6 TrustZCredibility can gain the trust of and provide effective services to groups with special needs particularly those in extreme poverty A close relationship with these people fosters trust whereas those who have been poor for a long time or feel disconnect with a government even a democratic one Once this relationship has been established it is difficult for even a new wellmeaning government to repair lf governments are seen as corrupt people may trust NGOs 7 Representationladvocacy NGOs hold advantages in understanding the needs of the poor who are otherwise excluded from political processes and even local deliberations It is not a comparative advantage for the public or private sector to advocate for the poor Planning Goals Costbenefit analysis to decide on the worth of projects involving public expenditure it is necessary to weigh the benefits and costs to society as a whole Social profit the difference between social benefits and social costs 1 Simplify the objective function to be maximized net social benefit with some measure of how different benefits are to be calculated 2 Obtain social measures of the unit values of all project inputs and outputs shadow prices The greater divergence between shadow prices and market prices the more costbenefit analysis needed 3 Decision criterion to index the stream of projected social benefits and costs Corruption the abuse of public trust for private gain a form of stealing Todaro indexes of corruption regularly rate the incidence of corruption far higher in developing countries than in developed countries Poor governance practices such as bribery controls over the press and limits on civil liberties are often found together and are mutually reinforcing Absence of corruption encourages investment Eimination of corruption is important because it promotes growth and sustainably high incomes Association of eliminating corruption with public empowerment subjects that it is a direct objective of development While the rich pay many bribes in corrupt regimes the poor generally pay a much larger fraction of their incomes in bribes and extortion Corruption is a regressive tax Countries successful in tackling corruption tend to promote competition and entry in the economy avoiding too much power in the hands of large monopolies such as those in the energy sector and have ensured that privatized firms face competition promoted civil service professionalism with increased pay for public servants made public expenditures transparent reduced immunity from presecution of public figures provided judicial independence Bardhan Article Two types of corruption 1Bureaucratic corruption direct corruption through bribes to individuals etc 2poitica corruption when government policies are llfor sale such as to special interest groups in the US How do we quantify corruption Usually by people s perception of it Caveat This is based on how many corrupt transactions we see around us Someone in India who sees an officer bribed for a traffic violation daily reports higher corruption than someone in the US who doesn t notice political corruption such as the purchasing of defense equipment under the table Caveat 2 Perceptions are based on ideas of foreign business people who experience corruption different from what domestic business people face Rankings usually measure bureaucratic corruption not political Economists emphasize incentives and organizations in corruption while other disciplines emphasize cultural norms or morality For this reason what is corrupt in one country may be a routine transaction in another due to norms We need an explanation of why similar countries may settle for different norms in similar transactions Types of Corruption Excessive regulation where bureaucrats are the only ones who understand and use this as a chance to exploit Bureaucrats are bribed to do what they re supposed to do yet they promise to do it quicker Yet this gives them incentive to move slower and collect more money You cant go to court and complain about this Bureaucrats are bribed to do what they re not supposed to do In this case both briber and bribee are at fault and neither has incentive to report the case Tends to be more persistent Econ looks at centralized corruption you pay one person to do what you need one stop shop and decentralized corruption coordination problem you don t know who to bribe which is inefficient If everyone else is corrupt you might as well be It decreases your chance of being caught and everyone assumes you are anyway Poicies for fighting corruption Aboish complicated regulations However this is naive Just because a food distribution system for the poor is corrupt doesn t mean we should abolish the system Just because those who monitor pollution take bribes doesn t mean we shouldn t monitor pollution Pursue the bribegiver if you pursue the bribe taker they will simply just relax their monitoring behavior and the factory will produce more pollution lnstead pursue the factory lntroduce incentive pay structure in civil service run services with a fewer number of people but pay them better There is a significant relationship between relative wage and corruption in countries lntroduce more competition One passport office in India is more corrupt than going to any post office in the US If they ask you for a bribe you can simply go to the next one Overlapping jurisdictions between offices help such as the FBI checking the NYPD Checks and balances in the government Political corruption can be reduced by using public funding of campaigns encouragement of transparent donation policies to campaigns free and equal time on TV and radio etc Poitica accountability TAXES Types of Taxes Taxes on consumption Turnover VAT excise Taxes on trade import duties and export taxes Taxes on income labor wage taxes and social security taxes or on business and investment income Taxes on assets Wealth and inheritance taxes property and land taxes Type of tax Economic Equity Cost to Collect Efficiency Income 1 most Can be progressive 10 of revenue Sales 2 Regressive 5 of revenue Trade 3 Potentially less 1 of revenue regressive Taxation depends on 5 factors Level of per capita real income Degree of inequality and distribution of income ndustria structure of economy Social political and institutional setting and relative power of different groups Administrative competence honesty and integrity of the tax gathering branch Taxes in LDCs Personal Income Property Tax much less revenue in LDCs than in MDCs It is too costly and regressive to collect taxes from the absolute poor and governments have not been persistent enough in collecting them from the rich Property usually reflects income inequality so property tax can be efficient but it is rarely used Corporate income usually less than 3 of GDP compared with 6 in developed countries LDCs offer tax incentives to corporations because they want investment Foreign companies often get up 15 years exemption Indirect taxes on commodities Easy to access and the largest source of public revenue in LDCs Especially true of foreign commodities More and more switching to a value added tax Problems depends not only on efficiency of taxes but efficiency of institutions which enforce them This depends on the political will of the government which has been trying to expand tax nets to cover high income groups and eliminate tax evasion more progressive Monetary Policy Issues Monetary policy means controlling the growth of the money supply and influencing the level of interest rates in order to affect the rate of economic growth Monetary policy can be used to accommodate fiscal policy or as an independent policy Effectiveness of monetary policy is also partly determined by exchange rates fixed vs floating Central banks have several functions ssue currency and manage foreign reserves Banker to the government Banker to domestic commercial banks Regulator of domestic financial institutions Operator of monetary and credit policy Role vs Capability Countries have low capability if they have a poorly developed financial system Financia system functions Providing payment services inconvenient to always carry cash Matching savers and investors Unlikely that one saver will save exactly as much as one investor wants to borrow Financial systems solve this problem Generatingdistributing information aggregate information of hundreds of investors stockbond prices Allocating credit efficiently Pricing pooling and trading risks ncreasing asset liquidity makes it easier to sell investments Financia system is constructed of Commercial banks 5 Insurance companies 6 Former capital markets stock markets If financial system is poor a country may be wiser to adopt an alternative to a central bank transitional central banking institution an intermediate step between a currency board and a central bank with the government exerting a strong influence supranationalcentral bank a bank for a group of smaller countries participating in a monetary union such as a customs union a currency enclave provides a degree of stability to LDC currency such as dollarization However this leaves the country dependent on the owner of the currency 0pen economy central banking institutionboth commodity and international capital flows represent significant components of national economic activity Development banks specialized public and private financial institutions that supply medium and long term funds for the creation or expansion of industrial enterprises Primarily rely on loans from aid agencies USAID world Bank or from their own governments Privatization Chile When pension system was privatized in 1981 Savings rate increased from 8 of GDP 1981 to 27 of GDP 1998 The Implied conclusion reform 9 increased savings 9increased investment 9GDP growth Reform Workers required to put in at least 10 of their salaries into privately managed pension funds Chile shifted from a lldefined benefit program like US Social Security to a quotdefined contributionquot program Expected benefits Savings rates go up because a the contributions gt voluntary savings levels and b higher expected returns will prompt more savings Financial sector competition more efficient capital markets Reduction in labor market distortions formal sector growth Actual changes Savings rate increased Stock market capitalization rose Emergence of longterm corporate bond market Employment in legally registered jobs increased Only 23 of workers involved in new program The fiscal cost of pensions to retirees and returning payments to younger workers will initially lower savings Thus other causes could have produced the change GDP growth prudent financial management Defense Spending in LDCs in 2000 military expenditures in LDCs accounted for 275 of military spending in the world There is a tendency to find higher HDI standing than predicted by per capita income among low militaryburden countries Vice versa for high spenders Spending in past years has shifted from paying armies to accumulating sophisticated weaponry Developing countries account for 75 of the world s arms purchases The opportunity costs of this are high resources are scarce Supporters argue arge benetifts of increased aggregate demand generated by military spending increase G employment creating of employment and training opportunities construction of basic infrastructure opportunity costs are smaller because resources devoted to military consumption are more likely to go to private consumption Costs of military spending are likely to reduce levels of human capital formation and private investment thus lower long term economic growth Most empirical data points to lower growth Counters if you want infrastructure build it Don t use the military training used by the military can be implemented in other ways unlike how the Koreas use their military as a training ground for the private sector


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